Slowing Down The PACE?

A 10-year-old government financing vehicle that incentivizes renewable energy and energy efficiency is now in jeopardy of having its impact reduced and, quite possibly, eliminated.

Property Assessed Clean Energy, or PACE, financing works like this: the property owner agrees to a long-term property tax assessment in exchange for upfront funding to pay for an energy efficiency or renewable energy upgrade. The upfront costs of such retrofits, which can be cost-prohibitive, are instead financed over a period that can be as short as 3 years and as long as 20 years. The interest rates on these loans are typically higher than a traditional mortgage rate, but lower than a credit card’s.

The shifting of debt enables the property owner to more quickly realize the positive cash flows of a reduced energy bill. Just like the upgrades, the debt obligation remains with the property should it be sold before the debt is repaid. This assessment is a disclosure in the real estate process, but ideally, the reduced energy bills would also be shared with potential buyers. Because the debt is tied to the property tax, PACE financing has a high rate of repayment. (PACE financing can be allowed for commercial projects through private capital firms, too.)

Finally, according to a study published in the Journal of Structured Finance (Jan. 2016), PACE financing was found to have a net positive effect on the resale value of homes.

PACE programs aren’t just limited to commercial or residential projects. Industrial, non-profit, and agricultural properties can also be eligible. And the retrofits aren’t restricted to energy, either. Windproofing, seismic retrofits, water conservation upgrades, and septic tank improvements can all qualify for financing. In that light, PACE doesn’t just help protect the environment, but it also creates jobs and promotes local economic development.

PACE financing originated in California in 2008, but it initially struggled to gain traction. The Federal Housing Finance Agency (FHFA) almost eliminated it in 2010, but the lending mechanism managed to survive and even started to thrive. By the end of 2010, 24 states and the District of Columbia had passed PACE legislation. To help ensure the viability of PACE programs, the PACE Assessment Protection Act (also known as HR 4285) was introduced in the House of Representatives in 2014, but it never went further than a referral to the House Committee on Financial Services.

Even though PACE has never received much love from Congress, it doesn’t necessarily need it. Because it is a form of a lien, PACE must be enabled at both the state and county level, which makes it a very local decision. To that end, there are now 30 states and the District of Columbia that have approved commercial PACE financing, and 16 states and D.C. that have passed residential PACE legislation. It should be noted that only 13 states and D.C. have active PACE programs, and only 3 of those states (CA, MO, FL) utilize it for residential purposes.

Unfortunately, it seems PACE financing is coming under attack from the federal government once again. HB 1958, a bi-partisan bill cleverly titled “Protecting Americans from Credit Entanglement” (PACE) Act of 2017, was introduced in early April. Not long after, a companion bill with the same name was introduced by four Republican Senators in mid-May. The intent of this legislation is to require PACE to meet the requirements of the Truth in Lending Act (TILA). We probably all agree that protecting consumers against fraud is a good thing, especially in the wake of recent shenanigans in the financial world. However, lawyers for Renew Financial believe that the legislation would characterize home performance contractors as “selling” PACE financing, and would therefore have to become licensed mortgage brokers. If the legislation were to pass, and if that interpretation were to hold true (two big ifs), few (if any) contractors would obtain their broker’s license, and understandably so.

The other threat to the future of PACE is the House FY2018 Transportation and Housing and Urban Development appropriations bill. There is language in the bill that could severely hamper the future of PACE, specifically: “The Committee includes bill language prohibiting funds from being used to purchase, guarantee, or insure any mortgage on properties that have a PACE loan in a first lien position—superior to the FHA loan.”

The first lien issue has always been the Achilles heel of PACE financing, and it’s why this lending mechanism has drawn the ire of both the Mortgage Bankers Association and realtor groups. It’s understandable why lenders would be upset with a secondary loan having higher repayment priority. As the bill states,

“Loans repaid by a tax or assessment enjoy a first lien position and, therefore, have priority in receiving proceeds in the event of a foreclosure. A PACE loan would be fully satisfied before the FHA mortgage.”

We’re almost 3 years removed from the FHFA prohibiting Fannie Mae and Freddie Mac from purchasing or refinancing a mortgage with an existing first lien PACE loan. And therein lies why the federal government continues to hound what is otherwise a state and county-level program: the involvement of Fannie and Freddie in so many loans.

However, the THUD appropriations bill does make an unjust implication. It reads: “FHA’s subordinate position increases the risk of loss to the Mutual Mortgage Insurance (MMI) fund and by extension, taxpayers. The Committee notes that the MMI fund was forced to draw $1,700,000,000 from the U.S. Treasury just four years ago to cover projected losses on loans it guarantees, and just reached its statutory capital reserve level just two years ago.”

$1.7 billion is certainly a lot of money, especially if you’re projected to lose it. However, by including this statistic in this section of the bill, it implies that 10-figure loss is due to PACE financing. No evidence is ever given to support that implication. And for the sake of context, it should be noted that in the current appropriations bill, the Committee is recommending a limitation of $400 billion on loan guarantees in the aforementioned MMI program account. So, if the MMI program were to lose $1.7 billion in FY2018, that would represent 0.4% of all loan guarantees.

To put that in perspective, the S&P/Experian First Mortgage Default Index is at 0.66%. And when you take into consideration all loans, the Federal Reserve reports that the delinquency rate for all real estate loans was at 2.28% for Q2 2017. The MMI program would be outperforming the market, while fostering sustainability improvements, which also lower societal/governmental costs.

Since Congress is struggling to pass legislation, this may all be for naught anyway. But it was just reported that the House passed a $4 trillion budget, so the legislative logjam might be loosening. Though both of the aforementioned bills are 5-6 months old and still sitting in Committee, for those in the home performance industry, this is a topic worth monitoring.